Chapter 9 Inventories: Additional Issues

Chapter 9 Inventories: Additional Issues QUESTIONS FOR REVIEW OF KEY TOPICS Question 9 1 GAAP generally requires the use of historical cost to value assets, but a departure from cost is necessary when the utility of an asset is no longer as great as its cost. The utility or benefits from inventory result from the ultimate sale of the goods. This utility could be reduced below cost due to deterioration, obsolescence, or changes in price levels. To avoid reporting inventory at an amount greater than the benefits it can provide, the lower of cost or net realizable value (LCNRV) approach to valuing inventory was developed for companies that use FIFO, average cost, or any method other than LIFO and the retail inventory method. For companies that use the retail inventory method, the lower of cost or market (LCM) approach is used. Market equals replacement cost, except that market should not (a) be greater than NRV (ceiling) or (b) be less than NRV minus an approximately normal profit margin (floor). Both LCNRV and LCM result in the recognition of losses when the value of inventory declines below its cost, rather than in the period in which the goods are ultimately sold. Question 9 2 The LCNRV and LCM determination can be made based on individual inventory items, on categories of inventory, or on the entire inventory. Question 9 3 If inventory write-downs are commonplace for a company, losses usually are included in cost of goods sold. However, when a write-down is substantial and unusual, GAAP requires that the loss be expressly disclosed. This could be accomplished with a disclosure note or, instead of including the loss in cost of goods sold, by reporting the loss in a separate line in the income statement, usually among operating expenses. Even with separate line item reporting, a disclosure note still would be appropriate. Question 9 4 The gross profit method estimates cost of goods sold, which is then subtracted from cost of goods available for sale to obtain an estimate of ending inventory. The estimate of cost of goods sold is found by multiplying sales by the historical ratio of cost to selling prices. The cost percentage is the complement of the gross profit ratio (1 GP%). Solutions Manual, Vol.1, Chapter 9 9 1 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Answers to Questions (continued) Question 9 5 The key to obtaining accurate estimates when using the gross profit method is the reliability of the cost percentage. If the cost percentage is too low, cost of goods sold will be understated and ending inventory overstated. Cost percentages usually are based on relationships of past years, which aren t necessarily representative of the current relationship. Failure to consider theft or spoilage also could cause an overstatement of ending inventory. Question 9 6 The retail inventory method first determines the amount of ending inventory at retail by subtracting sales for the period from goods available for sale at retail. Ending inventory at retail is then converted to cost by multiplying it by the cost-toretail percentage. Question 9 7 The main difference between the gross profit method and the retail inventory method is in the determination of the cost percentage used to convert sales at selling prices to sales at cost. The retail inventory method uses a cost percentage, called the cost-to-retail percentage, which is based on a current relationship between cost and selling price. The gross profit method relies on past data to reflect the current cost percentage. Question 9 8 Initial markup Original amount of markup from cost to selling price. Additional markup Increase in selling price subsequent to initial markup. Markup cancellation Elimination of an additional markup. Markdown Reduction in selling price below the original selling price. Markdown cancellation Elimination of a markdown. Question 9 9 When using the retail method to estimate average cost, the cost-to-retail percentage is determined by dividing total cost of goods available for sale by total goods available for sale at retail. By including beginning inventory in the calculation of the cost-to-retail percentage, the percentage reflects the average cost/retail relationship for all inventories, not just the portion acquired in the current period. 9 2 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Answers to Questions (continued) Question 9 10 The lower of cost or market (LCM) retail variation combined with the average cost method is called the conventional retail method. The LCM rule is incorporated into the retail inventory estimation procedure by excluding markdowns from the calculation of the cost-to-retail percentage. Question 9 11 When applying LIFO, if inventory increases during the year, none of the beginning inventory is assumed sold. Ending inventory includes the beginning inventory plus the current year s layer. To determine layers, we compare ending inventory at retail to beginning inventory at retail and assume that no more than one inventory layer is added if inventory increases. Each layer carries its own cost-toretail percentage that is used to convert each layer from retail to cost. Question 9 12 Freight-in is added to purchases in the cost column. Net markups are added in the retail column before the calculation of the cost-to-retail percentage. Normal spoilage is deducted in the retail column after the calculation of the cost-to-retail percentage. If sales are recorded net of employee discounts, the discounts are deducted in the retail column. Question 9 13 The dollar-value LIFO retail method eliminates the stable price assumption of regular retail LIFO. In effect, it combines dollar-value LIFO (Chapter 8) with LIFO retail. Before comparing beginning and ending inventory at retail prices, ending inventory is deflated to base year retail using the current year s retail price index. After identifying the layers in ending inventory with the years they were created, in addition to converting retail prices to cost using the cost-to-retail percentage, the dollar-value LIFO method requires that each layer first be converted from base year retail to layer year retail using the year s retail price index. Question 9 14 Changes in inventory methods, other than a change to the LIFO method, are reported retrospectively. This means reporting all previous periods financial statements as if the new inventory method had been used in all prior periods. Solutions Manual, Vol.1, Chapter 9 9 3 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Answers to Questions (continued) Question 9 15 When a company changes to the LIFO inventory method from any other method, it usually is impossible to calculate the income effect on prior years. To do so would require assumptions as to when specific LIFO inventory layers were created in years prior to the change. As a result, a company changing to LIFO usually does not report the change retrospectively. Instead, the LIFO method simply is used from that point on. The base year inventory for all future LIFO determinations is the beginning inventory in the year the LIFO method is adopted. Question 9 16 If a material inventory error is discovered in an accounting period subsequent to the period in which the error is made, any previous years financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. And, of course, any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on income from continuing operations, net income, and earnings per share. 9 4 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Answers to Questions (concluded) Question 9 17 2016: Cost of goods sold overstated Net income understated Ending retained earnings understated 2017: Net purchases no effect Cost of goods sold understated Net income overstated Ending retained earnings correct Question 9 18 When applying the lower of cost or net realizable value (LCNRV) rule for valuing inventory according to IFRS, if circumstances reveal that an inventory write-down is no longer appropriate, it must be reversed. Reversals are not permitted under U.S. GAAP. Also, under U.S. GAAP, the LCNRV rule can be applied to individual items, inventory categories, or the entire inventory. Using the international standard, the assessment usually is applied to individual items, although using inventory categories is allowed under certain circumstances. Question 9 19 Purchase commitments are contracts that obligate the company to purchase a specified amount of merchandise or raw materials at specified prices on or before specified dates. These agreements are entered into primarily to secure the acquisition of needed inventory and to protect against increases in purchase price. Question 9 20 Purchases made pursuant to a purchase commitment are recorded at the lower of contract price or market price on the date the contract is executed. A loss is recognized if the market price is less than the contract price. For purchase commitments outstanding at year-end, a loss is recognized if the market price at yearend is less than the contract price. Solutions Manual, Vol.1, Chapter 9 9 5 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

BRIEF EXERCISES Brief Exercise 9 1 NRV = $30 4 = $26 Cost = $20 Because the cost of $20 is lower than the NRV of $26, the unit value is $20. Brief Exercise 9 2 (1) (2) Product Cost NRV (*) Per Unit Inventory Value [Lower of (1) and (2)] 1 $50 $64 $50 2 34 32 32 * Selling price less costs to sell. Lower of Cost or Cost NRV Product 1 (1,000 units) $50,000 $50,000 Product 2 (1,000 units) 34,000 32,000 Cost $84,000 Inventory value $82,000 Before-tax income will be lower by $2,000, the amount of the required inventory write-down. 9 6 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 3 Replacement cost = $18 Ceiling = $30 $4 = $26 Floor = $26 ($30 30%) = $17 Because replacement cost is between the ceiling and floor, Market = $18. Cost = $20 Because the market of $18 is lower than the cost of $20, the unit value is $18. Brief Exercise 9 4 (1) (2) Product Cost Market (*) Per Unit Inventory Value [Lower of (1) or (2)] 1 $50 $54 $50 2 34 26 26 Replacement cost NRV (ceiling) NRV NPM (Floor) Product 1 $48 $70 $6 = $64 $64 $10 = $54 Product 2 $26 $36 $4 = $32 $32 $8 = $24 * Market is the middle amount for each product Lower of cost or market is $50 per unit for Product 1 and $26 per unit for product 2. Lower of Cost Cost or Market Product 1 (1,000 units) $50,000 $50,000 Product 2 (1,000 units) 34,000 26,000 Cost $84,000 Inventory value $76,000 Before-tax income will be lower by $8,000, the amount of the required inventory write-down ($84,000 $76,000). Solutions Manual, Vol.1, Chapter 9 9 7 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 5 Beginning inventory (from records) $220,000 Plus: Net purchases (from records) 400,000 Cost of goods available for sale 620,000 Less: Cost of goods sold: Net sales $600,000 Less: Estimated gross profit of 30% (180,000) Estimated cost of goods sold (420,000) Estimated cost of inventory destroyed $200,000 9 8 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 6 Beginning inventory (from records) $150,000 Plus: Net purchases (from records) 450,000 Cost of goods available for sale 600,000 Less: Cost of goods sold: Net sales $700,000 Less: Estimated gross profit (? ) Estimated cost of goods sold (? ) Estimated cost of inventory lost $ 75,000 Estimated cost of goods sold = $600,000 75,000 = $525,000* Estimated gross profit = $700,000 525,000* = $175,000 $175,000 $700,000 = 25% gross profit ratio Solutions Manual, Vol.1, Chapter 9 9 9 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 7 Cost Retail Beginning inventory $ 300,000 $ 450,000 Plus: Net purchases 861,000 1,210,000 Freight-in 22,000 Net markups 48,000 Less: Net markdowns (18,000) Goods available for sale 1,183,000 1,690,000 $1,183,000 Cost-to-retail percentage: = 70% $1,690,000 Less: Net sales (1,200,000) Estimated ending inventory at retail $ 490,000 Estimated ending inventory at cost (70% $490,000) (343,000) Estimated cost of goods sold $ 840,000 9 10 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 8 Cost Retail Beginning inventory $ 300,000 $ 450,000 Plus: Net purchases 861,000 1,210,000 Freight-in 22,000 Net markups 48,000 Less: Net markdowns (18,000) Goods available for sale (excluding beg. Inventory) 883,000 1,240,000 Goods available for sale (including beg. Inventory) 1,183,000 1,690,000 $883,000 Cost-to-retail percentage: = 71.21% $1,240,000 Less: Net sales (1,200,000) Estimated ending inventory at retail $ 490,000 Estimated ending inventory at cost: Retail Cost Beginning inventory $ 450,000 $ 300,000 Current period s layer 40,000 71.21 % = 28,484 Total $ 490,000 $328,484 (328,484) Estimated cost of goods sold $ 854,516 Solutions Manual, Vol.1, Chapter 9 9 11 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 9 Cost Retail Beginning inventory $ 300,000 $ 450,000 Plus: Net purchases 861,000 1,210,000 Freight-in 22,000 Net markups 48,000 Goods available for sale 1,708,000 $1,183,000 Cost-to-retail percentage: = 69.26% $1,708,000 Less: Net markdowns (18,000) Goods available for sale 1,183,000 1,690,000 Less: Net sales (1,200,000) Estimated ending inventory at retail $ 490,000 Estimated ending inventory at cost (69.26% (339,374) $490,000) Estimated cost of goods sold $ 843,626 9 12 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 10 Cost Retail Beginning inventory $220,000 $ 400,000 Plus: Purchases 640,000 1,180,000 Freight-in 17,800 Plus: Net markups 16,000 1,596,000 $877,800 Cost-to-retail percentage: = 55% $1,596,000 Less: Net markdowns (6,000) Goods available for sale 877,800 1,590,000 Less: Normal spoilage (3,000) Net sales Employee discounts (1,300,000) (15,000) Estimated ending inventory at retail $ 272,000 Estimated ending inventory at cost (55% $272,000) (149,600) Estimated cost of goods sold $728,200 Solutions Manual, Vol.1, Chapter 9 9 13 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 13 Hopyard applies the FIFO cost method retrospectively; that is, to all prior periods as if it always had used that method. In other words, all financial statement amounts for individual periods that are included for comparison with the current financial statements are revised for period-specific effects of the change. Then, the cumulative effects of the new method on periods prior to those presented are reflected in the reported balances of the assets and liabilities affected as of the beginning of the first period reported and a corresponding adjustment is made to the opening balance of retained earnings for that period. The effect of the change on each line item affected should be disclosed for each period reported as well as any adjustment for periods prior to those reported. Also, the nature of and justification for the change should be described in the disclosure notes, as well as the cumulative effect of the change on retained earnings or other components of equity as of the beginning of the earliest period presented. 2018 cost of goods sold is $7,000 higher than it would have been if Hopyard had not switched to FIFO. This is because beginning inventory is $18,000 higher ($145,000 127,000) and ending inventory is $11,000 higher ($162,000 151,000). An increase in beginning inventory causes an increase in cost of goods sold, but an increase in ending inventory causes a decrease in cost of goods sold. Purchases for 2018 are the same regardless of the inventory valuation method used. Brief Exercise 9 14 When a company changes to the LIFO inventory method from any other method, it usually is impossible to calculate the income effect on prior years. To do so would require assumptions as to when specific LIFO inventory layers were created in years prior to the change. As a result, a company changing to LIFO usually does not report the change retrospectively. Instead, the LIFO method simply is used from that point on. The base year inventory for all future LIFO determinations is the beginning inventory in the year the LIFO method is adopted, $150,000 in this case. A disclosure note is needed to explain (a) the nature of and justification for the change, (b) the effect of the change on current year s income and earnings per share, and (c) why retrospective application was impracticable. 9 14 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 15 The 2016 error caused 2016 net income to be overstated, but since 2016 ending inventory is 2017 beginning inventory, 2017 net income was understated by the same amount. So, the income statement was misstated for 2016 and 2017, but the balance sheet (retained earnings) was incorrect only for 2016. After that, no account balances are incorrect due to the 2016 error. Analysis of 2016 ending inventory error effects: U = Understated O = Overstated 2016 2017 Beginning inventory Beginning inventory O Plus: net purchases Plus: net purchases Less: ending inventory O Less: ending inventory Cost of goods sold U Cost of goods sold O Revenues Revenues Less: cost of goods sold U Less: cost of goods sold O Less: other expenses Less: other expenses Net income O Net income U Retained earnings O Retained earnings corrected Solutions Manual, Vol.1, Chapter 9 9 15 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Brief Exercise 9 15 (concluded) However, the 2017 error has not yet self-corrected. Both retained earnings and inventory still are overstated as a result of the second error. Analysis of 2017 ending inventory error effects: 2017 Beginning inventory Plus: net purchases Less: ending inventory Cost of goods sold O U U = Understated O = Overstated Revenues Less: cost of goods sold U Less: other expenses Net income Retained earnings O O Retained earnings on January 1, 2018, in this case, would be overstated by $500,000 (ignoring income taxes). Brief Exercise 9 16 The financial statements that were incorrect as a result of both errors (effect of one error in 2016 and effect of two errors in 2017) would be retrospectively restated to report the correct inventory amounts, cost of goods sold, income from continuing operations, net income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A prior period adjustment to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year s income from continuing operations, net income, and earnings per share. 9 16 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

EXERCISES Exercise 9 1 (1) (2) Product Cost NRV (*) Per Unit Inventory Value [Lower of (1) and (2)] 1 $ 20 $34 $20 2 90 80 80 3 50 60 50 * Selling price less costs to sell. Product NRV per unit 1 $40 $6 = $34 2 $120 $40 = $80 3 $70 $10 = $60 Exercise 9 2 (1) (2) Product Cost NRV (*) Per Unit Inventory Value [Lower of (1) and (2)] A $40 $52 $40 B 80 86 80 C 40 70 40 D 100 112 100 Solutions Manual, Vol.1, Chapter 9 9 17 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

E 20 26 20 * Selling price less costs to sell. Costs to sell = 10% of selling price and 5% of cost. Product Selling price Cost NRV per unit A $60 $40 $60 (10% $60) (5% $40) = $52 B 100 80 $100 (10% $100) (5% $80) = $86 C 80 40 $80 (10% $80) (5% $40) = $70 D 130 100 $130 (10% $130) (5% $100) = $112 E 30 20 $30 (10% $30) (5% $20) = $26 9 18 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 3 Requirement 1 (1) (2) Product Cost NRV Inventory Value [Lower of (1) and (2)] 101 $120,000 $100,000 $100,000 102 90,000 110,000 90,000 103 60,000 50,000 50,000 104 30,000 50,000 30,000 $300,000 $270,000 The inventory value is $270,000. Requirement 2 Write-down of inventory: $300,000 270,000 = $30,000 Cost of Goods Sold* 30,000 Inventory 30,000 * If the write-down of inventory was considered unusual, the debit would have been to a separate Loss account. Solutions Manual, Vol.1, Chapter 9 9 19 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 9 Beginning inventory (from records) $100,000 Plus: Net purchases (from records) 140,000 Cost of goods available for sale 240,000 Less: Cost of goods sold: Net sales $220,000 Less: Estimated gross profit of 35% (77,000) Estimated cost of goods sold (143,000) Estimated ending inventory 97,000 Less: Value of usable damaged goods (12,000) Estimated loss from fire $ 85,000 Exercise 9 11 Requirement 1 Beginning inventory (from records) $ 58,500 Plus: Net purchases ($110,000 4,000) 106,000 Freight-in (from records) 3,000 Cost of goods available for sale 167,500 Less: Cost of goods sold: Net sales ($180,000 5,000) $175,000 Less: Estimated gross profit of 40% (70,000) Estimated cost of goods sold (105,000) Estimated cost of inventory before theft 62,500 Less: Stolen inventory (8,000) Estimated ending inventory $ 54,500 Requirement 2 Solutions Manual, Vol.1, Chapter 9 9 21 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Beginning inventory (from records) $ 58,500 Plus: Net purchases ($110,000 4,000) 106,000 Freight-in (from records) 3,000 Cost of goods available for sale 167,500 Less: Cost of goods sold: Net sales ($180,000 5,000) $175,000 Less: Estimated gross profit of 50%* (87,500) Estimated cost of goods sold (87,500) Estimated cost of inventory before theft 80,000 Less: Stolen inventory (8,000) Estimated ending inventory $ 72,000 *Gross profit as a % of cost (1 + Gross profit as a % of cost) = Gross profit as a % of sales. 100% 200% = 50% 9 22 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 12 Beginning inventory + Net purchases Ending inventory = Cost of goods sold $27,000 + 31,000 28,000 = $30,000 = Cost of goods sold Cost percentage = Cost of goods sold Net sales $30,000 Cost percentage = = 60% $50,000 Solutions Manual, Vol.1, Chapter 9 9 23 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 14 Cost Retail Beginning inventory $190,000 $ 280,000 Plus: Purchases 600,000 840,000 Freight-in 8,000 Net markups 20,000 1,140,000 $798,000 Cost-to-retail percentage: = 70% $1,140,000 Less: Net markdowns (4,000) Goods available for sale 798,000 1,136,000 Less: Net sales (800,000) Estimated ending inventory at retail $ 336,000 Estimated ending inventory at cost (70% $336,000) $235,200 9 24 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 16 Cost Retail Beginning inventory $ 12,000 $ 20,000 Plus: Purchases 102,600 165,000 Freight-in 3,480 Less: Purchase returns (4,000) (7,000) Plus: Net markups 6,000 184,000 $114,080 Cost-to-retail percentage: = 62% $184,000 Less: Net markdowns (3,000) Goods available for sale 114,080 181,000 Less: Normal spoilage (4,200) Net sales (152,000) Estimated ending inventory at retail $ 24,800 Estimated ending inventory at cost (62% $24,800) (15,376) Estimated cost of goods sold $ 98,704 Solutions Manual, Vol.1, Chapter 9 9 25 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 17 Requirement 1 Cost Retail Beginning inventory $ 40,000 $ 60,000 Plus: Purchases 207,000 400,000 Freight-in 14,488 Less: Purchase returns (4,000) (6,000) Plus: Net markups 5,800 459,800 $257,488 Cost-to-retail percentage: = 56% $459,800 Less: Net markdowns (3,500) Goods available for sale 257,488 456,300 Less: Normal breakage (6,000) Sales: Net sales (280,000) Employee discounts (1,800) Estimated ending inventory at retail $168,500 Estimated ending inventory at cost (56% $168,500) (94,360) Estimated cost of goods sold $163,128 Requirement 2 Net markdowns are included in the cost-to-retail percentage: $257,488 Cost-to-retail percentage: = 56.43% $456,300 9 26 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 18 Net purchases: Using LIFO, the beginning inventory is excluded from the calculation of the cost-toretail percentage: Cost-to-retail percentage = Cost of goods available (excluding beg. inventory) Goods available at retail (excluding beg. inventory) $10,500 50% =, and = $21,000. x Net purchases at retail equals $21,000 less markups plus markdowns. Net purchases at retail = $21,000 4,000 + 1,000 = $18,000 Net sales: The cost-to-retail percentage can be calculated as follows: Cost Retail Beginning inventory $21,000.00 $ 35,000 Plus: Net purchases 10,500.00 18,000 Net markups 4,000 Less: Net markdowns (1,000) Goods available for sale 31,500.00 56,000 $31,500 Cost-to-retail percentage: = 56.25% $56,000 Less: Net sales (? ) Estimated ending inventory at retail? Estimated ending inventory at cost (56.25%?) = $17,437.50 Estimated ending inventory at retail is: $17,437.50.5625 = $31,000 Net sales = $56,000 31,000 = $25,000 Solutions Manual, Vol.1, Chapter 9 9 27 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 25 Requirement 1 The 2016 error caused 2016 net income to be understated, but since 2016 ending inventory is 2017 beginning inventory, 2017 net income was overstated by the same amount. So, the income statement was misstated for 2016 and 2017, but the balance sheet (retained earnings) was incorrect only for 2016. After that, no account balances are incorrect due to the 2016 error. Analysis of 2016 ending inventory effects: U = Understated O = Overstated 2016 2017 Beginning inventory Beginning inventory U Plus: net purchases Plus: net purchases Less: ending inventory U Less: ending inventory Cost of goods sold O Cost of goods sold U Revenues Revenues Less: cost of goods sold O Less: cost of goods sold U Less: other expenses Less: other expenses Net income U Net income O Retained earnings U Retained earnings corrected 9 28 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 25 (concluded) However, the 2017 error has not yet self-corrected. Both retained earnings and inventory still are overstated as a result of the second error. Analysis of 2017 ending inventory error effects: 2017 Beginning inventory Plus: net purchases Less: ending inventory Cost of goods sold O U U = Understated O = Overstated Revenues Less: cost of goods sold U Less: other expenses Net income Retained earnings O O Requirement 2 no es requerido Retained earnings (overstatement of 2017 income)... 150,000 Inventory (overstatement of 2018 beginning inventory)... 150,000 Requirement 3 The financial statements that were incorrect as a result of both errors (effect of one error in 2016 and effect of two errors in 2017) would be retrospectively restated to report the correct inventory amount, cost of goods sold, net income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A prior period adjustment to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year s income from continuing operations, net income, and earnings per share. Solutions Manual, Vol.1, Chapter 9 9 29 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 26 U = understated O = overstated NE = no effect Cost of Net Retained Goods Sold Income Earnings 1. Overstatement of ending inventory U O O 2. Overstatement of purchases O U U 3. Understatement of beginning inventory U O O 4. Freight-in charges are understated U O O 5. Understatement of ending inventory O U U 6. Understatement of purchases U O O 7. Overstatement of beginning inventory O U U 8. Understatement of purchases + understatement of ending inventory by the same amount NE NE NE 9 30 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 28 Requirement 1 The $42,000 should have been charged to purchases instead of advertising expense. This error caused 2017 net purchases and thus cost of goods sold to be understated and advertising expense to be overstated by $42,000. The understatement of ending inventory for the $30,000 in merchandise held on consignment caused 2017 cost of goods sold to be overstated. Analysis: U = Understated O = Overstated 2017 Beginning inventory Plus: net purchases U by 42,000 Less: ending inventory U by 30,000 Cost of goods sold U by 12,000 Revenues Less: cost of goods sold U by 12,000 Less: other expenses O by 42,000 Net income U by 30,000 Retained earnings U by 30,000 Requirement 2 NO ES REQUERIDO Inventory (understatement of 2018 beginning inventory) 30,000 Retained earnings (understatement of 2017 income) 30,000 Requirement 3 The 2017 financial statements that were incorrect as a result of the two errors would be retrospectively restated to report the correct inventory amount, cost of goods sold, advertising expense, income from continuing operations, net income, and retained earnings when those statements are reported again for comparative purposes in the current annual report. A prior period adjustment to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year s income from continuing operations, net income, and earnings per share. Solutions Manual, Vol.1, Chapter 9 9 31 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Exercise 9 31 If market price is less than the contract price, the purchase is recorded at the market price. June 15, 2018 Purchases (market price)... 85,000 Loss on purchase commitment (difference)... 15,000 Cash... 100,000 If market price at year-end is less than contract price for outstanding purchase commitments, a loss is recorded for the difference. June 30, 2018 Estimated loss on purchase commitment ($150,000 140,000) 10,000 Estimated liability on purchase commitment... 10,000 If market price on purchase date declines from year-end price, the purchase is recorded at market price. August 20, 2018 Purchases (market price)... 120,000 Loss on purchase commitment ($140,000 120,000)... 20,000 Estimated liability on purchase commitment... 10,000 Cash... 150,000 Solutions Manual, Vol.1, Chapter 9 9 33 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 2 Requirement 1 Product Cost Net Realizable Value (a) By Individual Products Lower of cost or NRV (b) By Product Type (c) By Total Inventory Tools: Hammers $ 500 $ 550 $ 500 Saws 2,000 1,800 1,800 Screwdrivers 600 780 600 Total tools $3,100 $3,130 $3,100 Paint products: 1-gallon cans $3,000 $2,500 2,500 Paint brushes 400 450 400 Total paint $3,400 $2,950 2,950 Total $6,500 $6,080 $5,800 $6,050 $6,080 Requirement 2 (a) Individual products = $6,500 5,800 = $700 (b) Product Categories = $6,500 6,050 = $450 (c) Total inventory = $6,500 6,080 = $420 Solutions Manual, Vol.1, Chapter 9 9 35 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 4 Requirement 1 Product Cost Market (a) By Individual Products Lower of cost or market (b) (c) By Product Type By Total Inventory Furniture: Chairs $1,250 $1,550 $1,250 Desks 730 580 580 Tables 1,680 1,840 1,680 Total furniture $3,660 $3,970 $3,660 Accessories: Rugs $2,400 $1,920 1,920 Lamps 660 540 540 Total accessories $3,060 $2,460 2,460 Total $6,720 $6,430 $5,970 $6,120 $6,430 Requirement 2 (a) Individual products Cost of Goods Sold 750 Inventory 750 ($6,720 5,970 = $750) (b) Product Categories Cost of Goods Sold 600 Inventory 600 ($6,720 6,120 = $600) (c) Total inventory Cost of Goods Sold 290 Inventory 290 ($6,720 6,430 = $290) 9 36 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 5 Requirement 1 Fruit Marshmallow Chocolate Toppings Toppings Topping Estimate of cost of goods sold: Cost percentage 80% 70% 65% Net sales $200,000 $55,000 $20,000 $160,000 $38,500 $13,000 Beginning inventory $ 20,000 $ 7,000 $ 3,000 Plus: Net purchases 150,000 36,000 12,000 Cost of goods available for sale 170,000 43,000 15,000 Less: Estimate of cost of goods sold 160,000 38,500 13,000 Estimate of cost of inventory lost $ 10,000 $ 4,500 $ 2,000 Requirement 2 The two main factors that could cause the estimates of the inventory lost to be over- or understated are: 1. The historical cost percentages used may not be representative of the current relationship between cost and selling price. 2. Theft or spoilage losses may not be appropriately considered in the cost percentage. Solutions Manual, Vol.1, Chapter 9 9 37 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 8 Requirement 1 Cost Retail Beginning inventory $ 20,000 $ 30,000 Plus: Purchases 100,151 146,495 Freight-in 5,100 Less: Purchase returns (2,100) (2,800) Plus: Net markups ($2,500 265) 2,235 175,930 $123,151 Cost-to-retail percentage: = 70% $175,930 Less: Net markdowns (800) Goods available for sale $123,151 175,130 Less: Normal spoilage (4,500) Net sales (135,730) Estimated ending inventory at retail $ 34,900 Estimated ending inventory at cost (70% $34,900) $ 24,430 Requirement 2 The difference between the inventory estimate per retail method and the amount per physical count may be due to: 1. Theft losses. 2. Spoilage or breakage above normal. 3. Differences in cost-to-retail percentage for purchases during the month, beginning inventory, and ending inventory. 4. Markups on goods available for sale inconsistent between cost of goods sold and ending inventory. 5. A wide variety of merchandise with varying cost-to-retail percentages. 6. Incorrect reporting of markdowns, additional markups, or cancellations. 9 38 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 9 ($ in 000s) Cost Retail Beginning inventory $ 80 $ 125 Purchases 671 1,006 Freight-in on purchases 30 Purchase returns (1) (2) Net markups 4 Net markdowns (8) Goods available for sale $780 1,125 Cost-to-retail percentages: Average cost ratio: $780 $1,125 =.6933 Conventional cost ratio: $780 ($1,125 + 8) =.6884 Deduct: Net sales (916) Ending inventory: At retail (sales price) $ 209 Average cost ($209.6933) $144.90 Conventional ($209.6884) $143.88 Note that the lower of average cost and net realizable value cost-to-retail percentage is approximated by excluding net markdowns. Solutions Manual, Vol.1, Chapter 9 9 39 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 17 Requirement 1 Accounts Accounts Sales Purchases payable receivable revenue Unadjusted balance $620,000 $210,000 $225,000 $840,000 Item: 2. (27,000) (27,000) 3. (25,000) (25,000) 6. (40,000) (40,000) 7. 18,000 18,000 Adjusted balance $586,000 $176,000 $185,000 $800,000 Requirement 2 Ending Cost of Inventory Goods Sold Beginning balance $ 414,000* $ 0 Close beginning inventory (414,000) 414,000 Close purchases (from requirement 1) 586,000 Unadjusted ending inventory 326,000 (326,000) Item: 1. (32,000) 32,000 4. 36,000** (36,000) 6. 22,000 (22,000) 7. 18,000 (18,000) Adjusted balance $ 370,000 $ 630,000 * $352,000 + 62,000 for the prior period adjustment in item 5. ** 1,000 units 100 units = 900 units $40 = $36,000 Alternatively: Beginning inventory ($352,000 + 62,000) $414,000 Plus: Purchases (from requirement 1) 586,000 Less: Ending inventory (370,000) Cost of goods sold $630,000 9 40 Intermediate Accounting, 9/e Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of

Problem 9 17 (concluded) Requirement 3 The 2017 financial statements that were incorrect as a result of the error would be retrospectively restated to report the correct inventory amounts, cost of goods sold, income, and retained earnings when those statements are reported again for comparative purposes in the 2018 annual report. A prior period adjustment to 2018 beginning retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on 2017 income from continuing operations, net income, and earnings per share. An understatement of ending inventory causes cost of goods sold to be overstated. Therefore, 2017 before-tax income was understated by $62,000. Solutions Manual, Vol.1, Chapter 9 9 41 Copyright 2018 All rights reserved. No reproduction or distribution without the prior written consent of